PSSLtd's (TWSE:6914) Soft Earnings Don't Show The Whole Picture

The most recent earnings report from PSS Co.,Ltd. (TWSE:6914) was disappointing for shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Check out our latest analysis for PSSLtd

Zooming In On PSSLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2024, PSSLtd recorded an accrual ratio of -0.85. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of NT$1.9b in the last year, which was a lot more than its statutory profit of NT$471.2m. PSSLtd's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, PSSLtd issued 10.0% more new shares over the last year. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out PSSLtd's historical EPS growth by clicking on this link.

How Is Dilution Impacting PSSLtd's Earnings Per Share (EPS)?

PSSLtd has improved its profit over the last three years, with an annualized gain of 324% in that time. In comparison, earnings per share only gained 238% over the same period. Net profit actually dropped by 6.0% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 9.8%. Therefore, the dilution is having a noteworthy influence on shareholder returns.

If PSSLtd's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On PSSLtd's Profit Performance

In conclusion, PSSLtd has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Based on these factors, we think that PSSLtd's profits are a reasonably conservative guide to its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that PSSLtd has 1 warning sign and it would be unwise to ignore it.

Our examination of PSSLtd has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.